Facebook's Value: What's the Price of a Billion People Watching Each Other?

Will Facebook's business model be more like Google, the New York Times, or TV? To be worth $100+ billion, it will have to be something much more.

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Is Facebook's IPO the next chapter in the greatest company of our time, or are Friday's buyers total suckers?

The only intelligent, honest, and true thing to say about this inevitable question is that nobody has any clue. In 1992, a company called America Online had a $70 million valuation after its IPO. A decade later, it was worth $150 billion. A decade after that peak, it is now worth only $1 billion. Online fortunes are built on hyper-active tectonic plates. Mountains of wealth accumulate from flat nothingness, rumble, push up toward the sky, and with alarming frequency, blow themselves up. The Internet is a super-seismic place.

The AOL of the 1990s and the Facebook of today are both penumbral Internet companies. Both permeated our lives in intimate ways. Both changed the way we interact with friends, receive information, and spend our time. Whereas AOL lived off subscriptions, and was vulnerable to competitors who offered Internet access for free, Facebook's currency is simply attention. Its competitors are, essentially, any company that can distract us more effectively.

Facebook's greatest asset is its immense capacity to distract us. The best social media companies manage to get 10% of their users to come back each day, according to Foursquare/Tumblr/Twitter/Zynga investor Fred Wilson. Ten percent isn't cool, Facebook contends. You know what's cool? Fifty percent. "The majority of Facebook users stay
active and their daily active user numbers are more than half their
monthly numbers," Jonah Peretti says, "meaning the majority of people login each day. It is
freakin' crazy."

It is freakin' crazy. If Facebook were merely the widest social network by number of users, dayenu. If it were the deepest social network by the quality of engagement and the quantity of personal detail, dayenu. But it's the widest and the deepest! That sort of thing has to be worth $100 billion, right?

Right?

THE CASE AGAINST FACEBOOK

In 1995, two students launched a website called TheGlobe.com from their Cornell dorm rooms. It resembled a proto-Facebook, letting users create personal pages with a place for pictures and writing. It had members (2 million) and a business plan (sell ads). The day of its IPO, TheGlobe.com's stock price sextupled -- a record pop for its time -- and approached $100. Where is it today? Exactly.

This calls for some context. TheGlobe.com's population was nearly the size of New Mexico and couldn't make money. Facebook's is nearly the size of India and it just made a billion dollars. Still, the New Yorker's John Cassidy calls Facebook "the ultimate dot-com," and he doesn't mean it as a compliment. To him, Mark Zuckerberg's juggernaut is TheGlobe.com on gorilla steroids. It has members (125 billion "friends"), engagement (300 million daily photo uploads), and a business plan (sell ads). But for a $100 billion valuation to make sense, Cassidy calculates that Facebook would have to make somewhere between $5 billion and $10 billion within a few years. Last year, Google made just shy of $10 billion.

Warning signs are twinkling. Between early 2011 and 2012, Facebook's costs grew at twice the pace of their revenue -- 95% to 45%. Its ad revenue declined in the first quarter of this year. This week, GM, the third-largest advertiser on Facebook, announced they have decided to remove all ads from the site. "It's not an advertising mechanism," said Martin Sorrell, chief executive of ad giant WPP.

But it is an advertising mechanism. Its short-term strategy is advertising -- the company makes four out of every five dollars of revenue from ads -- and its long-term strategy is advertising. The company reportedly hopes to turn user comments into mini ads. Either way, the future of Facebook depends on its 900 million users: how much detail we're willing to share, how many ads we're willing to take, and how valuable our attention on Facebook appears to be.

THE PRICE OF ATTENTION

Although Facebook earns more than 82% of its revenue from advertising, its IPO might not be the most important moment for Madison Avenue on Friday. This is the week that broadcast executives pitch their new shows to television advertisers. Billions of dollars of marketing will be decided by a few flashing screens of programming. Facebook should pay attention.

"One of the most successful forms of advertising ever is the yellow
pages," Michael Wolff writes in an insightful column this week. "Its costs are low enough to make its relative lack of
effectiveness still worthwhile to the advertiser, and there are enough
advertisers. That's the Google model; it's the
ultimate yellow pages. And that's the current Facebook model."

Facebook has to become more like TV, Wolff contends. Television ads work, because companies can buy slots of time between
programs that attract a certain kind of audience. The per-person costs
aren't high, as they're spread across millions of people. Even a pricey
for a 30 second-spot on
Desperate Housewives comes out to only 79 cents per household,
according to Eduardo Porter's The Price of Everything. This doesn't sound so different from Facebook, whose advertising works (in
theory), because companies can buy slots of space that attract a
particular kind of audience. As with television, it allows marketers to display
information to a segment -- such as guys born between 1970 and 1990 who
live in northern Virginia and like Coldplay.

But here's the rub. In 2011, Facebook made $4 per user per year. To earn its market cap of $100 billion today, it would have to earn five-times that figure per user. This sets up a tug-of-war over user information. Facebook has lots of it. Advertisers want to see more of it. Users want them to see less of it. The true value of Facebook could depend on who wins that turf war.

THE SOCIAL UNIVERSE

The upside is that Facebook has created something without precedent: an addictive product for hundreds of millions of people who spent their time creating, for free, something of huge importance to advertisers, which is personal information about their lives and interests. The downside is that Facebook is still extremely protective about the sort of ads it displays, partly because it's extremely sensitive to the fact that its users consider Facebook private. In a recent poll, more than half of respondents said they felt "not safe at all" using Facebook to purchases goods and services.

Ultimately, Facebook isn't like Google, or the yellow pages, or TV,
and it doesn't want to be. It wants to be something totally new: an infrastructure for the social web that can attract old-fashioned ads, create new ads that blend user content and marketing, create software that underpins that social web, and charge monopoly rents for its sprawling influence. And its
investors are betting on the fact that no company this wide, this deep, this addictive, and this influential could possibly fail.